While 80 percent of DWM
survey respondents say they are aware of the rising trend of interest-only
mortgages, a whopping 72 percent of those say they are worried what effect these
will have on the housing industry. Everyone seems to be concerned about the crop
of creative mortgage options that have emerged in recent years, including
Federal Reserve Chair Alan Greenspan. In fact, when he addressed the American
Bankers Association at its Annual Convention on September 26, 2005, Greenspan
addressed the key factors driving the U.S. economy in recent years including the
sharp rise in housing valuations and the associated buildup in mortgage debt.

“This enormous increase in
housing values and mortgage debt has been spurred by the decline in mortgage
interest rates, which remain historically low. Indeed, the 30-year fixed-rate
mortgage, currently around 5-3/4 percent, is about 1/2 percentage point below
its level of late spring 2004, just before the Federal Open Market Committee
embarked on the current cycle of policy tightening. This decline in mortgage
rates and other long-term interest rates in the context of a concurrent rise in
the federal funds rate is without precedent in recent U.S. experience.”

He
also noted that the low level of home mortgage interest rates has been a major
driver of the recent surge of homebuilding and home turnover and the steep climb
in home prices.

“The
apparent froth in housing markets may have spilled over into mortgage markets.
The dramatic increase in the prevalence of interest-only loans, as well as the
introduction of other, more-exotic forms of adjustable-rate mortgages, are
developments that bear close scrutiny. To be sure, these financing vehicles have
their appropriate uses. But to the extent that some households may be employing
these instruments to purchase a home that would otherwise be unaffordable, their
use is adding to the pressures in the marketplace.”

Greenspan
also addresses the plethora of loan choices now available. In addition to
interest-only options, some of those mentioned by Greenspan include:

·40-year
amortization schedules and adjustable rate mortgages.
These allow for a limited amount of negative amortization, according to
Greenspan. “These products could be cause for some concern both because they
expose borrowers to more interest-rate and house-price risk than the standard
30-year, fixed-rate mortgage and because they are seen as vehicles that enable
marginally qualified, highly leveraged borrowers to purchase homes at inflated
prices. In the event of widespread cooling in house prices, these borrowers, and
the institutions that service them, could be exposed to significant losses.”

·Piggyback
mortgages; second liens originated at the time of purchase.
These loans are popular, says Greenspan, because they avoid the non-deductible
private mortgage insurance payments required on larger, single loans. “If
piggyback loans are more common in states in which house price appreciation has
been particularly rapid over the past five years, one might worry that
homebuyers are especially exposed to reversals in house prices. However, data
collected for 2004, the first year of coverage in HMDA, show that the use of
piggyback loans was not particularly correlated with strong appreciation of
prices.”

·Of course,
the HMDA data do not track mortgages made by all institutions or open-ended
loans such as home equity lines of credit (HELOCs). Anecdotal reports suggest
that some homebuyers are using HELOCs as piggyback mortgages, and so we probably
do not have a full accounting of all mortgage debt.

·Long-Term
Variable (LTV). Greenspan says these are highest in states that have experienced
relatively little house price appreciation, and lowest in states in which prices
have appreciated the most, such as California and Massachusetts. “The main
reason for this negative relationship is likely that most people buying a home
in California are probably also selling a home in California and using at least
part of their accumulated home equity capital gains as a down payment on their
new house.”

While
it may seem that the picture looks bleak, Greenspan ended his speech with some
encouraging comments.

“Despite
the rapid growth of mortgage debt, only a small fraction of households across
the country have loan-to-value ratios greater than 90 percent. Thus, the vast
majority of homeowners have a sizable equity cushion with which to absorb a
potential decline in house prices. In addition, the LTVs for recent homebuyers
appear to be lower in those states that have experienced the most explosive
run-up in house prices and that, conceivably, could be at risk for the largest
price reversal. That said, the situation clearly will require our ongoing
scrutiny in the period ahead, lest more adverse trends emerge.”